8/14/2008 @ 10:20PM

The House Tobacco Built

The National Association of Attorneys General got rich off the tobacco settlement. Will it stop with cigarettes?

The air was thick with self-congratulation at the summer meeting of the National Association of Attorneys General in Providence, R.I. In a town infamous among industrial executives for handing the state a $2.4 billion jury verdict against lead-paint manufacturers, the AGs hailed their biggest litigation win so far: the $260 billion-plus tobacco settlement signed in 1998 to end lawsuits over tobacco-related medical costs.

Former Mississippi attorney general Michael Moore, who led the tobacco negotiations along with jailed private attorney Richard (Dickie) Scruggs, described the settlement as “one of the greatest public health measures in history.”

Washington Attorney General Robert McKenna, cochairman of NAAG’s Tobacco Committee, told the audience how an army of lawyers at NAAG and state AG offices keeps tabs on the tobacco industry, from monitoring sales to stepping in to halt taboo marketing tactics such as running cartoon ads in Rolling Stone.

Left unremarked upon was one of the largest beneficiaries of the settlement: NAAG. As part of the settlement it ended up with $103 million, since grown to $140 million. The earnings from that pot supplied most of the organization’s $26 million in revenue last year. The eight-story building in which NAAG occupies a floor belongs to the American Legacy Foundation, an antismoking group the AGs established in the settlement with $1.4 billion in tobacco-industry funding. NAAG paid $6.9 million for the floor.

Beside funding antismoking campaigns, the loot from the tobacco companies has helped turn this once sleepy professional association into a kind of super regulatory body, hunting for antitrust and consumer-fraud violations. It doesn’t sue anybody, instead working behind the scenes to coordinate the efforts of state attorneys general and provide legal advice.

“This is a de facto regulatory agency, they just don’t call it that,” says Michael S. Greve of the conservative American Enterprise Institute. “It corresponds to nothing we know about the constitutional landscape.”

The targets of multistate actions include
Microsoft
, which still operates under an intricate set of rules devised by lawyers working for the states and the Department of Justice;
Bristol-Myers Squibb
, which paid the states $58 million to settle antitrust claims over its Taxol cancer drug in 2003; and
Household International
and Ameriquest, which paid $809 million to settle predatory-lending cases. More recent targets include MySpace (online safety for minors), Guidant ($16.8 million for selling allegedly defective defibrillators) and aol (consumer complaints).

“I see a lot of money generated from the tobacco settlement being used to fund new investigations,” says Ashley Taylor, a former Virginia deputy attorney general who works for law firm Troutman Sanders in Washington, D.C. representing companies embroiled in multistate litigation. Taylor represented
ChoicePoint
after it was sued by 44 states in 2005 over consumer-credit privacy issues. He says NAAG attorneys provided advice.

The AGs haven’t gotten together again on anything as big as tobacco. NAAG has held two meetings on energy this year, where experts discussed issues including whether oil companies are driving up gasoline prices. California and several New England states have filed lawsuits against utilities and automakers over global-warming emissions. NAAG officials say any class actions spring from the initiative of individual states rather than from the association acting on its own.

“We don’t go out and target an industry,” says Idaho Attorney General Lawrence Wasden, the past president of NAAG. “We can’t sit around and act as some imperial force to enact policy however we want to.”

Unlike most nonreligious nonprofit associations, NAAG doesn’t file financial reports with the Internal Revenue Service. After a request from forbes, NAAG turned over three years’ audited financials. They show that the group and its foundation had $141 million in assets as of June 30, 2007.

A little-noticed 1999 amendment to the tobacco settlement steered $150 million to NAAG, ostensibly to reimburse the states for legal expenses. But only $97 million of that went back to the states. NAAG kept the rest, moving it to a charity called the Mission Foundation. It also got another $50 million to fund the operations of its seven-attorney Tobacco Project. NAAG contends the money belongs to the states and it only administers it.

As charities go, the Mission Foundation is rather tight with a dollar. It had $72.6 million in assets as of June 30, 2007 and $5.9 million in investment income, yet spent only $1 million on so-called program services, mostly training sessions for AG staff attorneys. That record wouldn’t sit well with the Better Business Bureau, which recommends charities spend no less than 65% of their income for charitable purposes.

Also within NAAG is something called the “milk fund” (named after a 1989 settlement of a school-milk case), where NAAG keeps money it gets from antitrust settlements. It uses the $2.8 million fund to pay economists and other experts. “We don’t have the resources that the defense has for expert advisers and the like,” explains Wasden.

Is this kosher, to steer money from state lawsuits to a professional association? “It may be perfectly legal, but it sounds awful,” says Larry E. Ribstein, an expert on financial litigation at the University of Illinois Law School. “These are the prosecutors–it’s their decision to settle the litigation, and now they’re seeking money for their coffers.”

Tobacco occupies most of NAAG’s attention these days. The organization is battling persistent, if thus far unsuccessful, legal attacks on the Master Settlement Agreement by smaller tobacco companies, who say it is an anticompetitive scheme that allowed the big manufacturers to raise prices indiscriminately. Since the settlement, Philip Morris’ share of the U.S. cigarette market has risen two points to 51% and its pretax profit per pack has climbed 85%; Liggett Group, for a long time controlled by financier Bennett LeBow, has pumped out half a billion dollars in dividends thanks to special, lower rates it pays under the settlement.

But here’s the absurdity of the settlement: Despite their good fortune, Philip Morris and other signatories to the settlement are suing to reduce their payments by as much as $1 billion a year. They claim the signatories collectively lost market share to new entrants because they raised their prices.

Much of what NAAG and the AGs do is conducted in secret. That confounds Mamaroneck, N.Y. attorney Leonard Violi, who’s suing the attorneys general of 30 states on behalf of the Canadian Iroquois Confederacy, who claim they’ve been shut out of the U.S. cig market. “You’re talking about the highest law enforcement officers of the states,” Violi says. “What do they have to hide?”